Investors are increasingly seeking diversification of risk and reward profiles across their investment strategies, with debt playing an important role, delegates at the Commercial Real Estate Finance Council Europe’s Autumn Conference in London heard last week.
During a panel discussion moderated by Lesley Chen Davison, director of banking and treasury at real estate investment firm Delancey, panellists discussed what diversification means to investors in the late-cycle market, with debt an increasingly common factor of strategies. Real Estate Capital was in attendance.
Lesley Chen Davison: Is diversification a necessity in all investment strategies, or can investors be choosier in the current market environment?
Dimme Lucassen, senior investment manager, Aberdeen Standard Investments: “Investors need to be very clear why they are investing outside their home markets. This is either for diversification benefits or to chase higher returns. I believe a lot of investors have historically gone up the risk curve in order to justify going abroad and in doing so have not gotten the diversification benefits they expected.”
Chen Davison: There has been a recent trend of equity investors looking at the debt space. What are the benefits of that?
Lee Coward, director, investments Europe, Oxford Properties: “We have had a lending programme in the US for eight years, with a $2.5 billion loan-book there; it was a good way to access product early on in our expansion into the US. In the UK, we were able to utilise equity to acquire assets, so credit opportunities were not the priority. More recently, Oxford has seen opportunities to access deals on a good risk-adjusted basis through entering the credit market. Opportunistically, accessing real estate through different parts of the capital stack makes sense to us.”
Emma Huepfl, co-founder and board director, Laxfield Capital: “Many investors today are equity and debt agnostic; they also invest globally and are open to a wide range of opportunities. We try to be poised to recognise the best parts of the debt market to invest into and be ready to take those opportunities to our investors, particularly in situations where banks are a little risk-off and there is a shortage of capital in certain areas.”
Lucassen: “We can invest in equity and debt. Primarily, our team focuses on equity, but debt is becoming increasingly more interesting.”
Chen Davison: Do investors currently care most about diversification, return, or capital preservation?
Anila Thompson, distribution director, global funds advisory, JLL: “We work with investors on their indirect real estate allocations. Across the investor base we deal with, we have seen a pick-up in appetite for real estate debt investments. Traditionally, we’ve been primarily focused on pure real estate equity investors, but as the debt space has become more diversified, there is more demand from investors to get exposure to debt. Additionally, as we get into a market where equity valuations look toppy in parts, certain investors are looking at debt to replace or complement their equity exposure. On the other hand, traditional fixed income investors, considering where interest rates are, are looking at real estate debt as an alternative and a way to capture the illiquidity premium.
“It is worth noting that within the debt space, there is diversification of investor appetite, depending on their portfolio requirements. Some of the real estate equity investors are looking for value-add-type returns out of their real estate debt allocations through investments in mezzanine debt. On the other hand, fixed-income investors now look at senior real estate debt as a way to pick up additional yield compared with what they would get in the public markets.”
Chen Davison: Is diversification everything, or is there a need for specialists?
Thompson: “There is certainly a need for diversification which also drives specialisation. On the one hand, large asset managers are diversifying their product offering, either through adding specialist teams or acquiring smaller managers; the M&A activity we’ve seen in the market of late is evidence of the latter. However, there is appetite for specialist managers with focused investment strategies, reflective of those managers’ areas of expertise, and we work with a few of them. For instance, we are working with a manager focused solely on select service hotels in Australia and New Zealand.”
Lucassen: “The majority of what we do is with specialist managers; for most mandates we have a clear view on the specific exposure we’re looking for. However, it’s getting more difficult for starting specialist managers to establish themselves as a result of regulatory and capital requirements.”
Huepfl: “In the UK in the last decade, the opening of the debt market to non-bank lenders means there is more diversification by risk appetite; a lot more specialists are able to find different ways of providing debt to suit the structure of their capital and risk appetite. That has happened very efficiently in the UK, led straight after the financial crisis by the first wave of US insurance companies coming into the UK market and bringing a slightly different approach, and followed by many other types of investors – all of whom have brought fresh perspective.”
Chen Davison: What investment risk would you prefer in the market?
Huepfl: “Retail opportunities will come about in the next 12 months, although we are extremely cautious. If retail warehousing reprices further, that segment could become interesting off rebased rents, or where there is an opportunity for part change of use of a retail asset to residential or leisure, for example. Would we contemplate lending 75 to 80 percent LTV? There would have to be a very visible opportunity to add value to the asset in the near term for us to take that sort of risk.”
Coward: “Office development is in our DNA, so, if the time is right, we will do new developments. From a credit perspective, 75 to 80 percent LTV lending is attractive to us, on the assumption we are compensated for it. Belief in the asset, business plan and the sponsor are more important at those levels.”
Chen Davison: What is your view on political risk?
Coward: “The reality is Oxford established its first offices outside Canada in the midst of the global financial crisis in the UK and US because we considered them the most stable markets. The last two to three years have shown that cannot be taken for granted, but if you have long-term, patient capital, you don’t have to make rash decisions. However, over the last couple of years Oxford has sped up its expansion into a broader investible universe; we set up an office in Singapore in January to invest more in Asia-Pacific and in Europe we broadened our horizons to include build-to-rent and logistics.”